Author: Tiezhu Ge in CRYPTO
At the beginning of the year, invited by Talk Jun@TJ_Research, and@qinbafrank and @viviennaBTC
We discussed the macro situation for next year, it was very enjoyable and enlightening.
Taking this opportunity, I’d like to share a more comprehensive view on next year's macro outlook.
This is a series covering dollar liquidity, U.S. Treasuries, and the U.S. dollar, incorporating views on monetary and fiscal policies. Due to space limitations, many details cannot be fully expanded upon. Analyzing liquidity, Treasuries, and the dollar is a massive financial engineering task; I've grasped some basics and hope to offer some insights.
I. A Deeper Understanding of Dollar Liquidity: The Impact of the Fed and G-SIBs
In the opening article of 2025, I systematically discussed how the Fed's balance sheet affects dollar liquidity (see link at the end). However, in today's market increasingly dominated by fiscal policy, analyzing the Fed alone is far from sufficient.
From a balance sheet perspective, dollar liquidity is not just the numbers on the Fed's balance sheet. It should be more accurately defined as the willingness and ability of financial intermediaries (especially G-SIB banks) to expand their balance sheets under the current risk appetite.
The entire financial system is essentially a layered nesting of balance sheets, where each layer represents the payment promise of the entity above it. Although the Fed's role as the lender of last resort remains crucial, in practical operation, dollars do not flow directly from the Fed to the market. They must be intermediated through the balance sheets of large banks, influenced by regulatory constraints and capital charges, and transformed into financial liquidity that is tradable and leveragable in the markets.
In other words, the perceived and actually usable dollar liquidity in financial markets depends not only on the Fed, but more so on whether banks, as intermediaries, are willing and at what cost to actually release these dollars.
This issue becomes particularly critical when we realize that the reserve balances in the banking system have declined to a level that still seems ample but is no longer宽松 on the margin.
The market's reaction to dollar liquidity is highly asymmetric: in other words, it doesn't react much to slight easing; but once it tightens, it becomes very disruptive. This situation is likely to persist for some time in 2026, making the analysis of bank balance sheets very important from a dollar liquidity perspective.
II. Deconstructing Dollar Liquidity: Nominal Liquidity and Usable Liquidity
A well-known formula for measuring total dollar liquidity is: Fed Balance Sheet Total - TGA (Treasury General Account) - Overnight Reverse Repo (RRP). This formula worked well before 2025 because bank reserves were过剩, and the balance sheet did not constrain the intermediation capacity of dollars. In other words, nominal liquidity was roughly equal to实际可用.
Entering the second half of 2025, the market's dollar liquidity has essentially shifted from a quantity constraint to an intermediation constraint. Simply put, the dollar intermediation capacity of banks has been greatly limited. This is like the relationship between water level and water pressure.
Global G-SIBs (Global Systemically Important Banks) are basically constrained by a series of regulatory standards set by the BIS (Bank for International Settlements).
Post-2010, this is mainly the new Basel III accord. This agreement, in a nutshell, uses various regulatory indicators to curb banks' impulse for scale. The core indicators introduced leverage ratio (SLR) and liquidity coverage (LCR/NSFR) requirements, specifically increasing capital requirements and comprehensive risk coverage for important banks.
Therefore, under these regulatory requirements, from a balance sheet perspective, banks' business orientation must consider: how much capital will be占用, and will it affect the achievement of regulatory indicators.
The SLR definition is simple: Tier 1 Capital / All on- and off-balance sheet assets (Treasuries, loans, derivatives, etc.). Generally, this ratio is 3%, but for large banks (over $250 billion in size), this ratio is 5%. Under this formula, holding U.S. Treasuries and making loans占用 capital equally.
The resulting outcome is: at certain key moments, constrained by capital占用, banks inevitably choose high-ROI businesses; low-yield activities like Treasury market-making and repo will decrease.
The key analysis here is the Treasury repo (Repo) market. The main participants in the Repo market are MMFs, banks, and hedge funds. Banks play the role of market makers. Then, at quarter-end, to meet regulatory indicators, when hedge funds borrow from banks by抵押 Treasuries, these抵押 U.S. Treasuries enter the bank's balance sheet and占用 Tier 1 capital.
Once a bank's capital占用 or balance sheet space is limited. Then, as the lender of funds, the bank either stops lending or significantly raises interest rates.
The result is: some funds, to survive (e.g., margin call), have to sell Treasuries at any cost. At this point, you see U.S. Treasury yields soaring, accompanied by a surge in SOFR rates.
Another very important factor is the RLAP requirement (Regulatory Intraday Liquidity). The regulation requires that at any moment on any trading day, banks must have sufficient, readily available high-quality liquidity to应对极端 situations of fund outflows.
Therefore, although you can see that bank reserves are not low, a portion is locked in. In other words, banks tend to maintain more ample reserves. This also exerts influence on times like quarter-ends.
III. How to Analyze the Tightness of Dollar Liquidity
Before further discussing indicators for monitoring dollar liquidity, another key variable needs to be clarified: the pressure on offshore dollars.
From the operating mechanism of the global dollar system, the U.S. dollar does not only circulate domestically in the U.S. On the contrary, a large amount of dollar credit is created, rolled over, and leveraged outside the U.S. And this offshore dollar system highly relies on foreign exchange swaps (FX Swap) and cross-currency financing to borrow dollars.
Non-U.S. banks do not have a base of dollar deposits and will use FX Swaps to convert local currency liabilities into dollar liabilities. Therefore, objectively speaking, it reacts faster to liquidity changes than onshore dollars.
Therefore, roughly, we can derive a simple analytical framework for dollar liquidity: Offshore funding cost - Onshore repo pressure - Bank balance sheet behavior - Asset price reaction.
1) Offshore Dollar: Cross-currency basis (core: USD/JPY basis / EUR/USD basis). It represents the borrowing cost for banks raising dollars in the offshore market; and the FX Swap points. The more negative the former and the larger the latter, it basically indicates increasing offshore funding pressure at the current stage.
2) Onshore Dollar: Core analysis is the Repo market, mainly look at the deviation between SOFR and IORB,配合 the MOVE index. If SOFR consistently exceeds the policy level, it indicates banks are unwilling to lend funds. Of course, a more in-depth look can focus on Treasury auction performance and repo market rates; large fluctuations or increases also indicate funding pressure levels.
3) Bank Balance Sheet Behavior: For example, an increase in RRP not accompanied by a rise in Repo, or a rapid increase in SRF usage, etc.
In addition, a decrease in liquidity intermediation capacity can also bring about anomalies not seen at other times, such as stocks and bonds selling off simultaneously, which may not be due to inflation but rather tightness in the repo market. Another example is abnormal widening of credit spreads, or even the possibility that good economic data反而 leads to tighter liquidity.
For some time, the market has been discussing whether the U.S. will relax SLR in 2026, essentially loosening the constraints on dollar liquidity intermediation, expanding balance sheet space, and avoiding sudden spikes in funding rates at key moments that force deleveraging chain reactions. Also, considering the current dollar weakness,持续 expanding fiscal deficit, limited room for rate cuts, and midterm elections. Foreseeable situations might include:
1) Indigestion of U.S. Treasuries: Even if rates are cut to around 3.0%, a smooth decline in the long end will still be very difficult.甚至 auction tails might not look good either, as the primary market's absorption capacity itself becomes the biggest constraint.
2) Changes in the TGA account will have a greater impact on the market. In today's environment where RRP is depleted, TGA's impact on Repo rate movements might be greater than before.
3) Changes in the Repo market: A massive amount of debt meeting funds desperately needing leverage means potentially greater volatility at quarter-ends, tax days, etc. Simultaneously, blow-ups in basis trades could also become the biggest tail risk.
Under the condition that SLR is not relaxed, easy money and tight credit will be the dominant market scenario for a period. The asymmetry of risk will be extremely prominent at the liquidity level. In a state of tight balance, with banks' willingness to expand their balance sheets suppressed, the significance of stock-bond correlation analysis will decline; they are more likely to collapse simultaneously, and the failure of the 60/40 portfolio may continue.
For ordinary people, cash remains an important defensive tool; meanwhile, gold, commodities, etc., can serve as very effective hedges. At the same time, when analyzing an asset, be sure to pay attention to which part of the liquidity transmission chain it is on. For example, altcoins or low-liquidity assets can easily dry up and experience flash crashes.
